Insights On Hard Money Cash-Out Refinancing

Back in 2006, I went to a weekend real estate investing seminar and listened to a real estate guru, who shared excellent information, tell myself and the other thirty people in attendance to “unlock the trapped equity in your homes” to use as capital for further real estate investments using 100% financing on as many properties as possible. In theory, this made complete sense to do bank or hard money cash-out refinancing at 8-13% in order to earn 30-40% cash-on-cash returns. But in practice, at the peak of the housing bubble in mid-2006, this was absolutely awful advice.

At that weekend seminar, I learned a lot about what real estate investors were doing or hoping to do with house flipping or developing parcels into condo projects. But I left Sunday evening with a nagging sense that this guy had just convinced the other 30 attendees that real estate would always appreciate at 10-25% annually even though I was talking to 10-15 California homeowners each week who couldn’t afford their homes and their existing mortgage and credit card debt loads who needed a mortgage financing miracle to hang on or else they’d be facing foreclosure and eventually bankruptcy.

There was a disconnect with what I was seeing professionally each week with real people’s loan applications and their credit reports versus the idea that the guru was selling that real estate always goes up and that the attendees would do great investing at the height of the easy credit fueled housing bubble and would do great investing later if the market had a downturn. (Selling “Hope”workseverytime!).

I know that several of the attendees invested in properties through the guidance of the guru as their paid consultant and even partnered with him on projects, with everyone losing their shirt when the housing markets in Arizona, California, and Nevada all tanked by 25-65%. Of course, there was fallout with everyone suing each other until they ran out of money to pay their attorneys, which then led them to take the next logical step of anonymously slamming the guru online.

Despite the fallout and the real estate guru malpractice of telling people to do 100% cash-out refinancing on everything they owned, I learned a lot of new information that weekend. And one of the most important things I learned is that when it comes to real estate, people will do some really stupid things or take really stupid advice from real or perceived experts and gurus if they think it will make them rich quickly.

It’s absolutely amazing to me how many people dream of getting rich quick through real estate. And how they’re willing to risk everything without the benefit of personal and in-depth working knowledge of the housing or mortgage markets in order to make it happen.

Each month, we field requests from real estate investors looking to pull as much cash out of their properties with hard money financing at 10-12% in order to get those 15-40% cash-on-cash returns by reinvesting the funds on other properties that they can acquire, rehab, and resell (Fix and Flip).

If there was no discipline on the part of the hard money lenders, the borrowers would take maximum leverage up to 100% Loan-To-Value (LTV) across as many properties as they could if this loan product was available. I’ve had these conversations with several house flippers and they are almost all 100% certain that they could service the debt on a 10-12% loan and that if the market abruptly turned downward, they’d be the first ones to dump their inventory before the rest of the market caught wind of the sell-off in real estate.

I love their overconfidence. I really do. It’s great. In the past, I’ve suffered from this malady of overconfidence in my personal abilities and my abilities to predict future events perfectly. Only in hindsight when I replay what I should have done had I only been smarter do I get it right every single time.

But that’s the fallacy of overconfidence and the trap of spending too much time dwelling on the past. We become too unrealistic about outcomes.

In the present, I work with several long-standing hard money lenders and their attorneys who will work with real estate investors who need to leverage their existing holdings in order to make a new acquisition that could yield a quick 40% or even 100% cash-on-cash return. We’ve seen 100%+ returns in just a few month’s time by some very experienced and successful real estate investors.

But, the lenders won’t give 100% cash-out on one property by itself. On refinances, they’ll consistently lend 60-65% LTV as the base loan limits and will go up to 70-75% LTV on the high end for a 12-month bridge loan or a fix and flip loan. Going up to 100% on a cash-out refinance, like the real estate guru from 2006 recommended, just won’t happen with any hard money lenders in today’s market.

In the end, I think we’re all better off with hard money lenders imposing conservative LTV limits on properties. House flippers have equity in their projects and won’t be leaving the lender with big losses if the market turns. Leveraging oneself to the hilt doesn’t make sense, especially after several years of rapidly rising real estate values like we’ve seen since 2012.

The best thing to do if you’re looking for maximum leverage from a hard money loan is to throw an extra property in as collateral, like this one up in Sacramento. As long as it makes sense to the lender, they’ll give you maximum leverage. But they just won’t give you all of it.